Federal Estate Tax and Cost-Basis

The Wall Street Journal ran an interesting article on the estate tax. Here is something that struck me:

At issue is the "step-up in cost basis" that all assets receive when an owner dies. The way the law is currently written, if the estate tax goes away, so does the step-up in cost basis. That's where the problem lies.

Step-up means that the property heirs receive is valued as of the date of death. So if Grandma leaves a grandchild stock selling for $75 a share that was bought in 1970 for $2 per share, the heir's "cost basis" in the stock is $75. If the grandchild then sells the stock for $80, the taxable gain is $5 per share. The same holds true for both real estate and personal property, like an heirloom ring or art.

If Congress fails to extend the current system for 2010, then at the owner's death all assets would retain their original cost, called "carry-over basis." Under this system the heir's stock would have a cost basis of the original $2 per share rather than $75. If he then sells the stock at $80, the taxable gain would be $78 instead of $5—a huge difference.